Since the JOBS Act of 2012 first went into effect, senior commercial real estate debt—offered via real estate “crowdfunding” platforms—has emerged as a popular fixed-rate investment for accredited investors. For the first time, individual investors can own small shares of large commercial real estate projects, accessed through online platforms, frequently for minimum investments of $5,000 or less.
These investments offer the potential for superior returns to Treasury bonds and other traditional fixed-rate vehicles, while also providing the security of the underlying property, which serves as collateral. These intuitive platforms allow investors to easily log on and view available offering pages, which include details about the property, market, borrower and returns.
However, you may often notice a curious omission: There is no information about the lender.
This is because, in many cases, the crowdfunding platform itself is acting as the lender and letting individual investors participate alongside it. In other words, investors are relying on crowdfunding platforms to do all of the requisite work: finding deals, underwriting them and structuring the loans.
While several established real estate crowdfunding platforms have built out teams with enough real estate experience to take on these responsibilities, there is another model available for investors: platforms that syndicate loans originated by experienced third-party lenders.
With the “syndication” model, an experienced lender issues a loan to a sponsor or developer on a project, but then passes along a portion of the loan to investors via an online platform. The lender still does the hard work—monitoring the project and borrower and making sure the borrower pays on time—while, theoretically at least, all investors have to do is collect a return.
Advocates of this model (including my company, Equity Multiple) say investing in a syndicated loan originated by an experienced lender has numerous advantages for investors. The most obvious is that investors are able to leverage the experience of an established lender, but investors are also the beneficiaries of an extra layer of due diligence.
With real estate debt, this generally includes analysis of the market, the property condition and location, track record of the borrower and other relevant factors to ensure that the investment is sound. In the syndication model, in addition to the lender’s due diligence, the crowdfunding platform should also conduct diligence before syndicating the deal to its investors.
The value of seasoned lenders can’t be overstated, as the experience they have can include local market knowledge and connections, expertise within a particular asset class (industrial, multi-family, etc.), repeat borrower relationships and an understanding of market cycles and loan workouts. This experience can help reduce the ultimate risk to investors in a significant way.
So how exactly does this work? The loan syndication process is relatively straightforward. The lender identifies the deal, diligences the borrower and property and then fully funds the loan. The platform only gets involved at this point, doing diligence on the lender itself before doing a second diligence process on the specific transaction.
For deals that pass this due diligence process, a portion of the total loan is syndicated to investors while some of the loan remains on the lender’s balance sheet, ensuring that the lender “keeps skin in the game” and has the incentive to continue servicing the loan. In other words, lenders continue to have their own money at risk if anything goes wrong, so they are motivated to make sure everything goes smoothly.
Generally, the original lender and the crowdfunding investors in the loan are on equal footing. When the lender succeeds in recouping principal and earning interest on the loan, investors in the syndicated loan will as well.
Somewhere, the ghost of Adam Smith is smiling at this process, for this is division and specialization of labor at work: Lenders all over the country bring their specific experience to bear, while the syndicating platform specializes in evaluating lenders, reviewing their transaction diligence and building great technology for investors.
The syndicated model also has an additional benefit for investors—it provides better diversification. Just as investors can benefit from diversifying their overall portfolio by including real estate and diversifying their real estate portfolio by investing in different markets and asset classes, they will also benefit by investing alongside a diverse range of lenders.
Despite the advantages of this syndication model, it is almost entirely absent on the debt side of real estate crowdfunding, which is not terribly surprising, considering the relative youth of the industry. Given the small size of most transactions on crowdfunding platforms and the focus on single family fix-and-flip properties, commercial lenders have, to a large extent, remained on the sidelines.
As the crowdfunding space matures and more commercial lenders explore the possibility of syndicating their real estate debt, we can expect the volume of these opportunities to increase. Lenders and investors alike see potential in these offerings, and investors will gravitate to platforms that provide access to better real estate, more comprehensive due diligence and more diversification opportunities for their portfolios.
While we have already seen the emergence of real estate crowdfunding as a legitimate investment alternative, the proliferation of syndicated real estate debt offerings from established lenders will be a crucial next step in the industry’s growth, which should attract more individual and institutional investors to the space.
[Editor’s Note: To learn more about this and related topics, you may want to attend the following webinars: Investing in Commercial Real Estate, Basics of Real Estate Syndication and Crowdfunding from the Investor’s Perspective. This is an updated version of an article originally published on May 11, 2016.]
©All Rights Reserved. May, 2020. DailyDAC™, LLC d/b/a/ Financial Poise™
Charles co-founded EQUITYMULTIPLE, an online real estate investment platform, in 2015 and is responsible for shaping the strategic vision of the company and overseeing its daily operations. Charles also sits on EQUITYMULTIPLE’s investment committee and board of directors. Prior to EQUITYMULTIPLE, Charles was a real estate attorney with Simpson, Thacher & Bartlett, where he worked…